The Gold Standard, Bretton Woods and Other Monetary Regimes: A Historical Appraisal

Bordo, Michael D., Federal Reserve Bank of St. Louis Review

INTRODUCTION

Two Questions

Which international monetary regime is best for economic performance? One based on fixed exchange rates, including the gold standard and its variants? Adjustable peg regimes such as the Bretton Woods system and the European Monetary System (EMS)? Or one based on floating exchange rates? This question has been debated since Nurkse's classic indictment of flexible rates and Friedman's classic defense.(1)

Why have some monetary regimes been more successful than others? Specifically, why did the classical gold standard last for almost a century (at least for Great Britain) and why did Bretton Woods endure for only 25 years (or less)? Why was the EMS successful for only a few years?

This paper attempts to answer these questions. To answer the first question, I examine empirical evidence on the performance of three monetary regimes: the classical gold standard, Bretton Woods, and the current float. As a backdrop, I examine the mixed regime interwar period. I answer the second question by linking regime success to the presence of credible commitment mechanisms, that is, to the incentive compatibility features of the regime. Successful fixed-rate regimes, in addition to being based on simple transparent rules, contained features that encouraged a center country to enforce the rules and other countries to comply.

The Issues

These questions touch on a number of important issues raised in economic literature. The first is the effect of the exchange rate regime on welfare. The key advantage of fixed exchange rates is that they reduce the transactions costs of exchange. The key disadvantage is that in a world of wage and price stickiness the benefits of reduced transactions costs may be outweighed by the costs of more volatile output and employment.

Helpman and Razin (1979), Helpman (1981) and others have raised the welfare issue. This theoretical literature concludes that it is difficult to provide an unambiguous ranking of exchange rate arrangements.(2)

Meltzer (1990) argues the need for empirical measures of the excess burdens associated with flexible and fixed exchange rates--the costs of increased volatility on the one hand compared with the output costs of sticky prices on the other hand. His comparison of EMS and non-EMS countries in the postwar period, however, does not yield clear-cut results.

Earlier literature comparing the macroeconomic performance of the classical gold standard, Bretton Woods and the current float also yielded mixed results. Bordo (1981) and Cooper (1982) showed that the classical gold standard was associated with greater price level and real output volatility than post--World War II arrangements for the United States and United Kingdom. On the other hand, Klein (1975) and Schwartz (1986) presented evidence that the gold standard provided greater long-term price stability than did the post--World War II arrangements.(3)

Bordo (1993) compared the means and standard deviations of nine variables for the Group of Seven countries under the three regimes, as well as the interwar period.(4) According to these measures, the Bretton Woods convertible period from 1959 to 1970 was the most stable regime for the majority of countries and variables examined. Eichengreen (1992a) measured volatility applying two filters (the first difference of logarithms and a linear trend).(5) Comparing Breton Woods and the float for a sample of 10 countries, he found no clear-cut connection between the volatility of real growth and the exchange rate regime. He also found no significant difference in the correlation of output volatility across countries between the two regimes.

A second issue is whether the exchange rate regime provides insulation from shocks and monetary policy independence. Under fixed rates, coordinated monetary policy may provide effective insulation from common supply shocks, but not from country-specific shocks. …

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